Baidu’s Key Business Drivers and Challenges In 2013

Baidu (NASDAQ:BIDU) is the leading online search provider in China. Its stock price has run up by over 50% in the past three months. In this article, we assess the key business drivers that have propelled this recent stock price movement. We also evaluate the key challenges being faced by the company.

The rising mobile monetization and investments in its online video vertical are likely to accelerate Baidu’s top line growth in the future. However, we believe increased competition in the search engine market and changing dynamics in the Chinese mobile Internet market are some of the factors that the company will have to address to maintain the positive momentum that’s fueling its stock price.

Baidu enjoys dominance over the Chinese online search market with a market share of over 70% on desktops. Moreover, it has a strong network of Baidu Union members which help grow its revenues. While there are several headwinds to Baidu’s market share in the future, we believe the company will continue to hold the largest share of the search market.

Increasing mobile monetization

Recent growth in its mobile monetization is one of the key factors that has driven an increase in Baidu’s stock price in the past few months. In Q2 2013, revenue from mobile devices accounted for over 10% of the company’s revenue. Investors were encouraged by this trend as it indicated that Baidu’s mobile strategy is starting to pay off. This trend will also drive top line growth, which is expected to accelerate in the third quarter.

Investments being made to bolster position in the mobile Internet space

The Chinese Internet market is seeing a rapid transition towards growing mobile usage. In line with this trend, most of the Chinese Internet companies are making significant investments to bolster their position in this market. The recent acquisitions of 91 Wireless and 59% stake in Nuomi by Baidu are expected to strengthen its play in the mobile market. We estimate that the company’s market share on mobile devices could rise in the future upon successful completion of these acquisitions.

Investments in the online video market could enhance the growth of the company

Baidu continues to make investments to enhance its position in the Chinese online video market. The acquisition of PPS (an online video provider) in May 2013 was a step in this direction. The integration of PPS with iQiyi, allowed the company to gain the largest market share (by number of mobile users). Recently, the company also launched smart TVs to expand its market. With the online video market expected to grow rapidly in China due to rise in advertising revenue, we believe Baidu will benefit from these investments.

Barriers

Low market share in the mobile search market

While Baidu has a huge market share on desktops, its market share on mobile devices is lower at around 37.5%.((China’s Baidu reports weaker profit growth in Q1, PCWorld, April 25, 2013)) Since the mobile search market in China is fragmented with various players including Tencent and Easou, we believe Baidu will find it difficult to grow its market share rapidly in the future.

Increasing competition from Qihoo

Baidu is also facing growing competition from Qihoo 360. Launched in August 2012, Qihoo has already gained more than 10% market share. According to estimates by T.H. Capital, Qihoo’s market share increased from 13.9% at the end of March 2013 to 15.6% by June 25, 2013.((Qihoo 360: TH Capital Sees Solid Quarter, Barron’s, July 9, 2013)) We believe that rising competition from Qihoo will affect Baidu’s growth in the future. Any unexpected increase in Qihoo’s market share could weigh on Baidu’s stock.

Other heavyweights in the Chinese Internet space such as Tencent and Alibaba also pose a threat to Baidu. Recently, Tencent expanded its presence in the search engine market by purchasing 36.5% interest in Sogou (a search engine by Sohu.com) for $448 million. [1] We believe the competition in the search engine market will intensify in the future, and this could result in lower Baidu market share. As the mobile Internet market is evolving in China, all the major players will compete aggressively to gain dominance in the market. We believe this factor will negatively impact Baidu’s stock in the short term.

Declining profitability

Baidu is facing pressure on its profitability due to increased investments in mobile strategy and infrastructure. In Q2 2013, its operating margin dropped to 38.4% as compared to 51.6% in Q2 2012. We expect its profitability to remain under pressure throughout 2013 due to the same factors.

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